Stagnation in the Canadian Housing Market

A LESSON IN TIMING, INCENTIVES, AND PSYCHOLOGY

The Aug 8^th 2012 edition of Canada’s Globe & Mail newspaper boldly stated that the country’s economists had reached a consensus: the bloated housing market will first slip 10-15%, and then “stagnate for years.”

The Frost Report has been warning prospective buyers about the coming decline of Canadian (and world) home prices since the first peak of February and March 2010 (see Spin City).  So, why are economists lagging so far behind?

First, the news is coming out now because it can.  The economists in the article -- who are employed by financial institutions -- have nothing left to lose since the market is “effectively exhausted” (their words).  People who have already bought homes have given the banks and brokerages their business, and can no longer benefit from the advice.  Those who don’t have homes after years of low interest rates either can’t afford them or don’t want them.

Secondly, economists have virtually no natural incentive to accurately predict slowdowns and price declines.  Nasty predictions about the most popular investment in the country (real estate) are unpopular, unwanted, and of no benefit to the companies who employ economists.

And then there are the clients…

It’s dangerous to advise a client not to buy real estate.  Contrary to what is taught in most investment psychology manuals, clients take declines in prices (“who could have known?”) far better than missed opportunities (“you said not to buy and prices went up 50%!”).  Furthermore, a client who has already decided to buy (which is typically why they are speaking with a banker or real estate agent in the first place) will never, ever listen to advice anyway.  If a client, who has already decided to buy, asks a banker if it’s a good time to do so and the banker replies, “I don’t believe it is,” that client will usually spend the next 15-20 minutes explaining to the banker why he is wrong.

The Cinderella party in Canadian housing is officially over.  I sincerely hope that the moderate 10-15% decline predicted by the nation’s top economists is accurate – but I doubt it.

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See also:

Canadian house prices to slip, then likely stagnate for years

Summer chill cools Toronto, Vancouver property markets

 
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Why are US Home Sales so Bad?

This week, many US news agencies reported that home sales are down, prices are weakening, and it's all deeply confusing. Since interest rates are falling, shouldn't home sales be rising? Isn't that what Economics 101 teaches us?

Pundits give many possible reasons for this strangely low level of sales: lack of available credit, bad seasonal weather, weak consumer confidence, weak jobs outlook, tough mortgage lending standards, and more. I believe all of these excuses are nonsense.

Banks are willing to lend, and have the cash to do so. Consumers have the highest credit ratings they have had in years. And, bad weather doesn't account for nationwide weakness.

The reason US home sales are low is because people with excellent credit and good jobs simply have no reason to buy. This explanation is far too simple for economists to embrace, yet it is true. Take, for instance, the conversation I heard on Friday:
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Banker: "I haven't seen you in a while. Did you buy that property in Phoenix you were looking at?"

Client: "No, not yet. Prices are great down there! But, they're not going up. I heard on the news they might still be dropping. I don't think there's any rush. I think I'll just sit tight."

Banker: "I agree."

Client: "The prices sure are great, though."
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I hear conversations like this every day.

Thousands of investors are waiting to "jump in," but there is simply no incentive to buy right now.

At some point, of course, prices will take off like a rocket ship - that is, slowly at first, gaining momentum steadily (once people realize prices are rising again) until going at full speed. However, no one knows when that point will be. It could be years.

Strangely, and counter-intuitively, I believe that in order to spur home purchases, the Fed should do exactly the opposite of what it is doing. That is, it should steadily increase interest rates. Last year, when the Bank of Canada announced that it would be raising rates, there was a frenzy of buying activity (which has since slowed, since they are now lowering rates). Contrary to every economics paper every written, I think the reality of rising rates would kick-start a home buying recovery.

In any case, my advice (as I have pointed out previously), is that if you want to buy real estate and are able to do so, do it now. Interest rates are extremely low, prices are extremely low, and with a large number of homes on the market you can choose whichever property your heart desires. Buying at a time like this will never be a bad investment.

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"Space is big. You just won't believe how vastly, hugely, mind-bogglingly big it is. I mean, you may think it's a long way down the road to the drug store, but that's just peanuts compared to space."

Douglas Adams

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See also:

If Mortgage Rates Keep Falling, Why Are Home Sales So Bad?

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Lessons from Aristocrats - Housing

An elderly client visited my office recently to inquire about the interest rate for a personal loan. The purpose of the loan, he said, was to purchase a new water heater to replace the one that had just broken in his home. The man’s home…a 2.5 million dollar Tudor-style mansion.

This incident reminded me of something that happened to me when I was a college student. I had answered an ad for a basement suite, and was surprised to find myself standing in front of a hundred-year-old residence complete with carved oak staircase, vaulted ceilings, a library, a study, and an observatory. The owner, who had fallen on hard times, had recently converted the damp basement into six rental suites with a shared kitchen, suitable only to college students who will accept this type of accommodation. I kept looking anyway.

Most aristocratic families have, in their history, a successful ancestor who builds a massive family residence to showcase the family’s success. Winston Churchill’s ancestor, the 1st Duke of Marlborough, for instance, built a massive residence named Blenheim Palace.

Subsequent generations develop businesses, pawn heirlooms, gamble, steal, and whatever else is necessary in order to maintain the family estate, some generations more successfully than others. At some point, the family gives up trying to maintain the entire building and moves into a single section, leaving the rest to decay.

Eventually, the family mansion is donated to charity or opened to the public as a tourist attraction, since poor people will pay money to see how rich people live. Sometimes this eventuality takes hundreds of years, and sometimes it occurs within the builder’s lifetime.

The Marlborough family has thus far kept their estate. Due to Winston Churchill’s book royalties, his family has preserved Blenheim palace intact. Before Winston became a famous author (and later politician), the survival of the family residence was in doubt.

In Canada, people have the peculiar habit of moving into larger and larger homes as they become more established, until finally, after the children leave the nest, they find themselves in a home with far more space than they need. In due course they retire, and spend six months of every year in the warm southern United States, living in a camping trailer and enjoying it because it’s “easy to maintain.”

For aristocratic wannabes (easily distinguished by the phrase, “I do a lot of entertaining at home”), remember the lesson you can learn from the mistakes of real aristocrats: buy a home that you can comfortably afford, with rooms that you will actually use. The idea of having 10 extra rooms will bring you much more pleasure that actually owning them.

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"Few rich men own their property; the property owns them."
Robert Ingersoll, speech, New York, 29 October 1896

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The Mortgage Foreclosure Mess

YET ANOTHER KICK AT THE CAN



US Bank stocks skidded downward this week, based on a moratorium on foreclosures. Major US banks, including Wells Fargo and Bank of America, are accused of (among other things) using “robo-signers”: employees who rubber stamp foreclosure documents without properly reviewing them.

The mass-producing and bulk-signing of documents has a disgusting and immoral aura to it, similar to the revulsion for traffic tickets issued by speed radar cameras.

Having an employee decide the fate of someone’s home without reading the documentation is cold-hearted, and people are understandably upset. Having said that, it isn’t like the banks haven’t been trying. Wells Fargo alone has 17 thousand employees working on foreclosure and mortgage modification paperwork: they are simply overwhelmed by the volume.

For the banks, any moratorium on foreclosures is definitely negative. Moving foreclosed homes into the stabilized marketplace has been an order of priority for months now.

As an investor, there is a series of questions that should be asked in any situation where the immediate outlook seems negative. 1) Is this going to reduce earnings, and therefore stock prices? 2) Will this cause the company to go bankrupt, resulting in a permanent loss of capital? 3) Will the reduction in earnings be permanent?

In this case, the answers are clear: yes, this is going to reduce earnings and stock prices (and already has); no, this is not going to cause the major banks to go bankrupt (since their balance sheets are already positioned to withstand major calamities); and no, the reduction in earnings will not be permanent.

As usual, where there is fear there is opportunity.

The big chance to load up on bank stocks was in Feb-Mar of 2009, but there have been several smaller opportunities since: this may be another one. While today’s drop in bank stocks was just a small bump in the 3-year chart, a few more days of declines will result in some real bargains.

Bank of America (BAC), Citigroup (C), Wells Fargo and Co. (WFC), and JP Morgan (JPM) have all dropped nicely. That is, four of the biggest banks in America - with the greatest profit potential - are on sale again. Depending on next week's hype, bank stocks could drop even further.

If you missed out on the biggest run (when banking index fund XLF went from $6 to $15 in about a year), this is looking like another fine opportunity.

Hope for fear!

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"If I owe you a Pound, I have a problem; but if I owe you a million (Pounds), the problem is yours."

John Maynard Keynes

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Disclosure
Do not buy stocks, sell short, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

The Canadian Real Estate Market: Trouble in the Pipeline

The Canadian Housing market is going well, with big volume and qualified customers. At least, that’s the current perspective at the end of the line. The further one goes up the pipeline, however, the worse the big picture looks.

A mortgage department employee from a major bank recently told me that application volumes are down 25% or more since June 15th. Though employees are not being laid off, those who leave or retire are not being replaced. At the same time, the quality of mortgage applications is deteriorating rapidly (“scraping the bottom of the barrel” was the exact expression).

Further up the pipeline, Real Estate agents tell me they are worried. Sales have dropped noticeably since May. In an attempt to make up the difference, agents are cold-calling and self-marketing like they have not done for a very long time.

Of course, all this is anecdotal evidence. At the bank level, sales numbers still look great. Yet, I suspect that the drying mortgage pipeline will reach Canadian banks soon. When it does, you will read about it here.

For further information, see:

Spin City
Canadian Debt II
World Housing Bubble II
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"Phew. With yesterday's report that home resales are cooling and price increases shrinking, we can finally put behind us the horror of Canada's great imaginary housing bubble. ...What Canada had was modest overvaluation with very little sign of speculation."

Jay Bryan, The Montreal Gazette, June 17 2010.

Reflexivity and the Decline in Home Sales

Recent headlines confidently announced that the 33% reduction in U.S. new home sales for May 2010 was due to the expiration of the new-home buyer’s tax credit at the end of April.

In other words, we are supposed to believe that home sales were robust due to an $8000 tax credit, and now that this credit is over the housing market is bust. Nonsense.

In fact, the reversal in new home sales was primarily caused by an equally large decline in psychological wealth that occurred at the beginning of May - which had nothing to do with tax credits.

Rapid declines in consumer spending are caused by rapid declines in asset values, such as stocks or real estate. While there is much talk about how a drop in stock prices can “predict” an economic downturn, there is little notice that a drop in stock prices, rather than predicting a downturn, may actually be the cause of one.

When people see their net worth decline, they compensate by saving. That is, they decrease their spending and increase their margin of safety, further exacerbating the symptoms of the decline.



The “flash crash” of May 6th 2010 punched the confidence out of retail investors, psychologically forcing them to transfer billions of dollars out of equity investments. So, while April saw inflows to equity mutual funds of $13.89 billion, May saw outflows of $29.94 billion (www.ici.org). Negative headlines caused retail investors to run for the hills - and they haven’t stopped running. These days, the market fluctuates wildly from the trades of hedge funds and volume traders, while those working with retail clients (such as Financial Planners and Brokers) sit at their desks, bored.

Stocks are reasonably priced, with little room for a disastrous collapse like the one from the peak. Home prices are low. Interest rates are low. Despite problems in Europe and Asia, the U.S. economy has all the logical conditions which make it ready to rise from the ashes. However, retail investors and consumers are anything but logical.

Until the chat-room anger and gloom subsides, both stock and housing markets will linger - and the buying opportunities for rational long-term investors will be sublime.
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“…the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.”
The Federal Reserve, Press Release, June 23 2010

“Housing cannot lift the United States from its new state of Marxist depression, you bunch of morons. The American Dream is just that. Rest in Peace, USA.”
Anonymous comment on a financial news website, June 24 2010
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See also: Reverse Attribution

The World Housing Bubble - Part II

Just in case you thought it was over...

Back in March, The Frost Report noted that during the economic crisis of 2006 and beyond, countries around the world drastically lowered interest rates to spur economic growth. Like the Frankenstein monster, the good intentions of these low interest rates have morphed into a hideous mess: a multinational, worldwide housing bubble.

Some economies have already moved from the "we don't have a bubble" stage to the "bubble is beginning to burst" stage, while others are still recovering from the first one. In case you missed the original article or it has faded from memory (see: World Housing Bubble), here is another selection of this year’s headlines to remind you that the problem is far from over.

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THE UK

House price rises ‘unsustainable’ as lending falls
The Times, June 2nd 2010

"Vicky Redwood, Capital Economics’ senior UK economist, said that the data 'continues to suggest that the recent rise in house prices is unsustainable'."

http://business.timesonline.co.uk/tol/business/industry_sectors/construction_and_property/article7142355


CHINA

May property sales plunge in Beijing, Shanghai, Shenzhen
Xinhua, June 2nd 2010

"Beijing, property signings slumped nearly 70 percent to 3,357 in May from April, the Shanghai Securities News reported, citing data from the city’s housing regulator. In Shanghai, transactions may have dropped about 70 percent to 2,550 signings, the paper reported, and in Shenzhen, sales fell 62 percent."

http://news.xinhuanet.com/english2010/business/2010-06/02/c_13328894.htm


AUSTRALIA

Interest rate rises subdue housing bubble
The Australian, June 1st 2010

"The Reserve Bank of Australia's rate rises have pricked the boom in housing prices and have also sent lending to businesses skidding into reverse."

http://www.theaustralian.com.au/business/property/interest-rate-rises-subdue-housing-bubble/story-e6frg9gx-1225873746105


KAZAKHSTAN

National Bank Chairman: Kazakhstan Focuses on Economic Recovery
Ministry of Foreign Affairs, May 4rth 2010

"Kazakhstan was one of the first countries to experience the global economic meltdown of credit. As a result, it was one of the first to respond with a comprehensive program to deal with problem sectors, such as banking, financial services and property development — the industries that created an economic ‘‘bubble’’ whose collapse the country is still recovering from."

http://portal.mfa.kz/portal/page/portal/mfa/en/content/news/ASTANA%20CALLING/2010-05-04


KENYA

As Nairobi Property Prices Rise, Home Buyers Suffer Low Returns
AllAfrica, Feb 22nd 2010

"Many people who have taken mortgages to buy rental properties are finding it increasingly difficult to service the loans since rents accrued are not sufficient to cover the monthly mortgage repayments.
At the heart of the problem is the fact that rents in many parts of Nairobi suburbs are facing a property price bubble."

http://allafrica.com/stories/201002221638.html


ISRAEL

Legal Ground: The end of easy mortgages?
The Jerusalem Post, May 28th 2010

"It was predictable that the Bank of Israel would move to cool the residential mortgage market. We have seen what anarchy of easy mortgages could do to a massive established economy like that of the US. Even more so, the collapse of a bank in a small economy such as Israel could be a disaster."

http://www.jpost.com/Business/Commentary/Article.aspx?id=176747


CANADA

House prices to drop: TD
The Globe and Mail, May 5th 2010

"House prices will fall in 2011, TD Bank said Wednesday as it revised its outlook for the Canadian real estate sector."

http://www.theglobeandmail.com/report-on-business/house-prices-to-drop-td/article1557540


TAIWAN

Taipei Real Estate Risks Grow After Record Rally
Bloomberg, May 20th 2010

"Investors should sell Taipei property now, taking advantage of a 21-month rally in prices before the government acts to make real estate more affordable, according to the Taiwan Real Estate Research Center and the island’s largest real-estate brokerage."

http://www.bloomberg.com/apps/news?pid=20601206&sid=a0cIUQ74Wfy0
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After today’s “hot economies” become tomorrow’s “busted economies” and real estate prices return to normal, the world map of economic health will need to be redrawn. Those with developed infrastructure and the ability to raise taxes will fare better, while emerging markets will likely be hardest hit.

If you have a margin account and/or trade international stocks, it would be wise to raise some cash (if you haven't already), to take advantage of bargains as they come available in the next 18 months.

Despite ongoing domestic problems, it is my belief that in a few years the United States - whose massive deleveraging has preceded and superseded all others - will look enviously safe and stable.

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"...in an environment in which the financial sector is prone to excess and the supervisory structure does not respond sufficiently, the interaction of low interest rates and financial vulnerabilities can clearly be dangerous."

Donald Kohn, Federal Reserve Board, 2010

Abouuuuut….Face!

The CREA Gets Real




Just seven days ago, I wrote an article stating that the Canadian Real Estate Association should be ashamed of themselves for their cheery and completely unrealistic assessment of the Canadian housing market (see: CREA to the Rescue).

Today, in a stunning about-face, the CREA "updated" its forecast, admitting that by 2011 a "demand-driven downturn" will push Canadian home prices lower. They even added that the threat of rising interest rates and new taxes caused buyers to jump into the market sooner than they may have otherwise (something I wrote about in April, in Spending 'til it Hurts).

It’s unclear what prompted the CREA to come clean. I’d like to think it was my blog, but more likely they simply realized that a small dose of reality now prevents egg-on-your-face later.

Of course, the CREA is still being idealistic (read "deceptive"). Amongst other nonsense, they insist that Canada’s "conservative lending practices" and mythical "prudent borrowing" will prevent a large price correction; that the two most overpriced markets (Ontario and B.C.) will inexplicably plateau next year after a small drop; and, of course that the current market shows a good balance between supply and demand. But, at least they aren’t encouraging a new wave of oblivious buyers. The CREA has, with its latest press release, gained back a shred of dignity.

I have to give credit where credit is due: the CREA did the right thing. More of the same would be nice.

For the CREA's full press release, see Housing Forecast Revised.
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"Home sales are coming down from the mountain peak, but they will level out at a high plateau -- a plateau that is higher than previous peaks in the housing cycle.”

David Lereah, Chief Economist, National Association of Realtors, USA 2006

U.S. Robin Hood Real Estate, Part II

In last month’s U.S. mortgage refinance program, the Democrats announced a comprehensive plan to help struggling homeowners. The plan allowed homeowners to refinance to a longer amortization (ex. 35 years) or reduce their interest rate in order to make monthly payments more affordable. This Friday’s announcement went one step further, allowing homeowners to actually reduce the amount of principle they owe (ie. write off the debt). In essence, the plan is a mass Chapter 11, funded by the taxpayer.

With this new plan, the home equity gamblers of 2005-2007 have really hit the jackpot. Although they lost equity in the real estate casino (which they chose to enter), the owner of the casino is now handing them their money back. Meanwhile, prudent people who didn’t gamble remain in apartments or living with their parents, driving compact cars instead of SUVs. It’s a deplorable affront to dignity and consequence.

In my view, if the big banks want to modify their mortgages to prevent further losses, they should be encouraged to do so; taxpayers, however, should have no part in it. Painful as it may be, let supply and demand work itself out, and let personal consequences matter.

See also Part I
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“The house doesn't beat the player. It just gives him the opportunity to beat himself.” Nick Dandalos, professional poker player

The World Housing Bubble

The title of this article is a bold statement…world housing bubble.

The near-failure of the U.S. economy in 2007 brought with it the ultimate Keynesian response: extremely low interest rates, all across the globe. Shockingly, although countries lowered their rates in response to a real estate collapse in America, the result has been bubble-like housing growth all over the world.

Consider this selection of recent articles…

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CHINA

Overseas realty proves safer bet
“More wealthy Chinese are buying overseas properties for better investment returns as skyrocketing property prices in the country makes domestic home purchases more risky.”

www.cs.com.cn/english/ei/201003/t20100322_2373066.htm


AUSTRALIA

House surge leads to mortgage stress
“VICTORIA'S resurgent housing market is putting borrowers under severe financial strain, even if they are employed or earn more than $80,000 a year.”

www.news.com.au/money/property/house-surge-leads-to-mortgage-stress/story-e6frfmd0-1225843130252


CANADA

House prices to hit record: Scotiabank
"Canada's housing boom will continue this spring as exceptionally low mortgage rates and the expectation that borrowing costs will soon be headed higher – add a sense of urgency to consumer buying."

www.theglobeandmail.com/report-on-business/economy/house-prices-to-hit-record-scotiabank/article1509303/


ISRAEL

This bubble won’t bust, if we build over the Green Line
"The great crisis in the financial market drove people out of financial assets while historical low interest rates made mortgages much cheaper. The feeling that the only safe assets are the old-fashioned ones, first and foremost solid buildings, combined with a wave of foreign Jewish investors rushing to buy homes in the land of the Jews as a kind of an insurance policy drove the prices of homes in Israel to the top."

www.jpost.com/Business/BusinessFeatures/Article.aspx?id=171505


SOUTH KOREA

Housing Market Bubble possibility not high nationwide
"A KCCI representative commented that 'although there are many ongoing debates about the possibility of housing bubble...the possibility of house bubbling is quite low,' and further added that 'we must rather focus and prepare ourselves for the possibility of sudden drops in house prices due to unstable economic situations.'"

english.korcham.net/bbs/viewnotice.asp?code=reports&page=1&id=460&number=460


U.K.

Fears grow that new mortgage drought could hit house prices
"House prices fell 1.5 per cent in February after seven months of uninterrupted growth, according to the Halifax, the UK’s biggest mortgage lender. It says that buyers were deterred from visiting estate agents by the severe cold weather and changes to stamp duty."

www.timesonline.co.uk/tol/money/property_and_mortgages/article7060101.ece


LEBANON

Salameh rules out any real estate bubble
"Central bank Governor Riad Salameh said on Thursday that he does not expect a real-estate bubble to take place in Lebanon, and that the surge in property prices in the country is due to a real increase in demand."

www.beirut-online.net/portal/article.php?id=6669


SWEDEN

Economists reject 'housing bubble' report
"Economists from state-owned mortgage lender SBAB have rejected as unfounded warnings from the National Housing Credit Guarantee Board (BKN) that Sweden stands on the precipice of a house price crash."

www.thelocal.se/25236/20100226/

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The worldwide economic recovery, which is only now taking shape, is threatened by the very thing that started the crisis in the first place: real estate. Only this time it doesn’t just involve a single country.

The world's economies are in a dangerous position. On one hand, increasing rates could slow down or even derail the recovery. On the other hand, the longer interest rates stay low, the more unsustainable long-term real estate prices will become.

Somewhat perversely, the U.S. economy seems to be the real winner here. After two years of suffering, U.S. banks have recapitalized and are sitting on cash; home prices are affordable; consumers have been paying down debt. Although the U.S. economy looks ragged at the moment, it is in the best position to move forward.

One can only hope that the world real estate reversal will be more anticipated, more orderly and more methodical than the earlier U.S. meltdown: yet somehow, I doubt it.

Investors can do some simple things to prepare for the inevitable. First, take some profits and build cash. That does not mean selling all your stocks, for heated markets can rise for much longer than you may think. It does, however, mean selling parts of your portfolio related to housing and construction. It also means making sure that if you have a margin trading account, you are using margin sparingly, if at all.

Most importantly, be vigilant -- which includes checking this website from time to time. When the “things have slowed down but are still fine” headlines start making regular appearances on the news, it’s time to start considering making money on the downside.

As manias subside, the result is never pretty.
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"When money is free [interest rates are lower than inflation], the rational lender will keep on lending until there is no one else to lend to." George Soros

The Canadian Housing Bubble – The Denial Continues...

I could talk about the Big 5 Banks’ meeting with the Bank of Canada, where they expressed concerns about a potential collapse in real estate prices. I could talk about rising mortgage debt as a percentage of income. I could talk about condo developments in areas with an abundance of rental suites available. I could talk about the increasing incidence of fraud. But, I think the bare facts speak loudest.

This home in Vancouver –for sale at $1.18 million.


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“Right now, there is no compelling evidence of a housing bubble in Canada." Jim Flaherty, Canadian Finance Minister, Feb. 2010
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Chinese-Style Bao Ba

A quick and dirty definition of a bubble is when, a) everyone thinks that an asset is overpriced, but b) they want to buy it anyway.

This is precisely the situation in China, where, according to state news agency Xinhua, 86% of investors believe that a housing bubble has begun; yet 92% expect prices to remain steady or rise. On average, investors expect a gain of 4.4% per quarter, or 17.6% per year! Recent adjectives used to describe the Chinese housing market include “rocketing,” “sizzling,” “surging” and “searing.” In capital city Beijing, a 950 sq ft apartment costs the equivalent of $2.8 million dollars to an American (roughly 0.65 month’s salary per square foot). And if all that were not enough, the General Office of the State Council (Jan 16th) issued a report noting that “excessively rising house prices have recently emerged in some cities,” and recommended “restraining purchases for speculators and investors.” Ouch!

When something is this obvious, it’s painful to watch.

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“One clear indication of a bubble is the rapidity of the price rise. Although there are occasions when sharp increases in the price of individual stocks are justified, this has never been true of market sectors.” Jeremy Siegel

The Canadian Housing Market

The bubble is back.

Not content with a single housing bubble, Canadians have apparently decided to ignore reality and give it a second go, especially in Vancouver. Just a few days ago, my mortgage broker confirmed that, just like in the bubble years, multiple bids on properties are back with a vengeance. A typical, two-bedroom bungalow/rancher in the West Side is now priced at 1.3 million dollars, right back to where it was at the peak in 2008.

A few different factors are responsible for this brutal overpricing. First is the typical Vancouverite’s belief that theirs is the greatest city in the world. Granted, Vancouver is a nice place. But, everyone seems to believe the city is so spectacular that Olympic visitors will return to London, Paris, Tokyo etc. and immediately put their homes up for sale so they can move to Vancouver.

Second and more important is the Asian factor. In Vancouver a substantial number of immigrants, mostly from China, are buying residences primarily or completely in cash. Cash purchases are a big factor in propping up high prices; however, they are an even bigger factor in the decision making process for local buyers. Vancouverites are convinced that because of immigration, prices cannot drop; therefore, any price is justifiable, as one will always find a buyer at that new higher price (in economics, this is known as “greater fool theory.”)

Finally, the average Canadian is making a mistake typical for those who know little about finance: they are concentrating on monthly payment amount instead of amount of debt owed. To the financially naive, owing $500,000 at a 2.25% variable interest rate with a monthly payment of $1718 is better than owing $400,000 at a fixed rate of 4% with monthly payments of $1763. More importantly, people are not aware that today's 2.25% variable interest rate, and the resulting barely-affordable monthly payment, will soon be going up.

The governor of the Bank of Canada, Mark Carney, is trying his best to send out the warning ("It is the responsibility of households now to ensure that in the future, when the recovery takes hold and extraordinary measures are unwound, they can service their debts”), but it’s largely falling on deaf ears. While Americans have spent the last two years paying down their credit card and mortgage debt, Canadians have been busy racking it up. The Bank of Canada estimates that by the 4rth quarter of 2011, Canadian personal debt payments will reach record-breaking levels (shattering the previous record set in 2000).

Of course, after the housing bubble bursts for the second time, we’ll probably hear a chorus of, “It’s the fault of the banks. They shouldn’t be approving these loans in the first place!” As a banker, I can say without hesitation that trying to tell a customer they can’t afford to buy their dream home is like telling a child they can’t have ice cream: they throw a tantrum, threaten to run away (take their business elsewhere), and frequently do exactly that. If the next bank doesn’t approve them, they will keep trying until someone does, eventually lying about their assets or income if necessary. People don’t seem to realize that when your banker (who wants to give out loans) tells you that you can’t afford it, maybe you should listen.

And so, the bubble grows…